What is an earnest money deposit and why is it necessary

When buying a home in a competitive market, you often need to use every advantage available to you, for buyers and sellers alike. If you are selling and have multiple offers, you will only want to entertain legitimate ones. If you’re a buyer, you need to demonstrate you are serious about your offer and certain there will be no issues preventing the deal from going through. One of the most common ways to back up your word is with an earnest money deposit.

If your offer is accepted and everything moves forward without incident, the deposit will go towards the down payment or closing costs. However, if the deal falls through, things can get a bit more complicated. All foreseeable circumstances should be stated in a contract agreement.

For all your home-purchase questions, speak with a loanDepot licensed loan officer for more information.

Money in waiting

The details involved in buying a home can be extensive, and even a "quick close" can take several weeks to complete. When earnest money is offered it is in a sort of "limbo" until the final details are set. Instead of clearly belonging to the buyer, who has offered up the money, or the seller, who is offering up the home, earnest money sits in escrow or with a closing agent.

If the sale of the home doesn't go through, there can be conflicting ideas on what happens to the earnest money. While it is usually a small percentage of the price of the home, it still is a significant amount of money. Because the money is going to be tied up, buyers usually don't want to over-inflate the figure, but they still want to send a clear message that they intend to buy the home. Your Realtor can help figure out an appropriate figure.

What if sale falls through?

Distribution terms are usually negotiated in the sales contract with a contingent date. If contingencies are not satisfied, the deposit should be returned to the buyer. The buyer and seller can usually decide how to split unapplied earnest money without a lot of difficulty, providing the contract was clearly written. If an issue discovered several weeks into the buying process results in the buyer no longer qualifying for the mortgage, the seller will likely keep a larger portion of the money, if not the entire deposit.

The potential buyer could also change their mind about a house. They might see something they like better, or discover damage to a home they did not notice at first. Again, these potential issues must all be addressed in the contract for them to be considered in the disbursement of the deposit.

No matter what the situation, it is in the best interests of the buyer and the seller to find an equitable solution. A legal battle will only take more of the earnest money off the table, and increase the amount of time it takes to get it back. While real estate agents aren't lawyers, many buyers and sellers find their insight helpful because they are more experienced when it comes to witnessing these types of situations, and can offer a different perspective.

The licensed loan officers at loanDepot can answer these and any other questions regarding a home purchase loan.

Published April 21, 2016

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